Alternative investments to lessen volatility

Prolonged stock market volatility has caused many investors to question how much of their portfolios should be allocated to equities. If the stock market is making you nervous, it’s important to understand that there are alternatives, which, when used along with stocks, may increase diversification and potentially lessen volatility. However, it’s just as important to understand that alternative investments also come with risks.

Alternative investments take many forms. Here is a look at several common investment types.

Real Estate Investment Trusts. REITs invest in groups of professionally managed properties such as office buildings, apartments, warehouses, or health care facilities. To qualify as a REIT, a company must invest at least 75 percent of its total assets in real estate, must derive at least 75 percent of gross income from rents or mortgage interest, and must pay at least 90 percent of its taxable income in the form of shareholder dividends. REITs trade on major exchanges and can be bought or sold as you would trade a stock.

Commodities. These investments include metals such as gold or silver, oil, and agricultural products. In the case of gold or silver, there are dealers who trade these precious metals. If you take physical possession of gold or silver, you will need to arrange for storage and insurance. Because many investors do not want to make these arrangements, investments that track the price of an underlying commodity are becoming more popular.

Private equity. Major categories of private equity include venture capital, leveraged buyouts, and mezzanine financing. Investors participate in private markets through collective vehicles such as partnerships that actively manage the investment assets on the investors’ behalf. Successful investing in this area requires the ability to assess complex financial structures, assume outsized risk in pursuit of superior reward, and tolerate extended periods of illiquidity. Private equity firms frequently require investors to make fairly large commitments.

Hedge funds. The term hedge fund is a catch-all phrase describing funds that follow aggressive investment strategies such as intensive use of derivatives and proprietary computerized trading. Hedge funds typically are engineered to seek a more favorable risk-adjusted return than their investors might obtain from a fund that follows a standard market benchmark. These funds are typically offered to investors whose portfolios include more than $1 million in financial assets.

All investing involves risk, including loss of principal; and alternative investments by themselves can be highly volatile. But when used in combination with stocks or other assets, they may help to smooth out long-term returns and provide an alternative when stock returns are choppy. Be sure to consult with your financial professional before investing.

The stock market has had quite a run. Portfolio management requires forward looking thinking and discipline. I am currently recommending that investors take a look at their asset allocation to make sure it hasn’t gotten out of balance. In addition, suitable investors should consider adding a little bit of these alternatives as they may help shelter from the next inevitable pullback.

For investors with $1 million-plus portfolios that would like a professional to comment on their overall portfolio structure, we do provide a free service in which we analyze your current game plan. I call it a cup of coffee and a second opinion. Most people find it a helpful and enjoyable experience.